A long, slow grind, not a sudden shock
A repricing of capital is coming soon. But advances in risk management suggest it will be a prolonged process, not a quick flip into deflation.
In the next 12 months, the asset and debt bubbles that underpin global imbalances and growth will be deflated. Today’s bubbles – from US consumer debt and much of the global housing market to the China story and umpteen bond markets – are all a result of underpriced capital. The cure, as always, will be a repricing and reduced supply of capital.
Financial markets will experience negative returns for bonds and equities, outperformance of gold and a weakening of the US dollar and the commodity currencies against the euro and the yen. Commodities will suffer from lower global growth and the hissing sound of hot air escaping from the China story. There will be shrinkage of risk appetite and a rise in volatility for most asset classes.
The US is the centre of all asset bubbles and excesses; it will pay the price for this. At the same time, the eurozone and Japanese economies are developing autonomous economic recoveries. Monetary policy in both Japan and the eurozone will tighten. The US will then be the sub-par performer in growth and inflation. The current gap between US and Japanese and European interest rates and growth will narrow.